Question

1. We discussed in the lecture that the coronavirus is both an AS and AD shock. Based on the lecture, draw a graph showing both of the movements. You need a properly drawn graph as you did for homework 4.

Update for clarity: For this question, we’re only capturing the effect of the virus itself. Don’t assume there are any particular policies associated with these shocks. It’s probably easiest to think of the AS shock as the reduced labor force as people get sick, and the AD shock as a reduction in consumption.

2. Draw a graph of the AS/AD model if the government becomes concerned about the deficit and decides to cut government spending. You need a properly drawn graph as you did for homework 4.

Answer 1

1. The decrease i supply due to more number of labourers becoming sick will shift the AS curve leftwards to AS’ and a decrease in consumer spending would shift the AD curve leftwards to AD’. This will unambiguously decrease the output from Y to Y’ but the impact on peice will depend on the fact that whether the fall in demand was more or fall in supply was more. If demand falls more than the supply, price will fall and vice-versa. But if the fall in both is equal then the price level will remain same. I’ve shown the case where demand falls slightly more than the supply (only out of consideration that people in most countries are under lockdown, so, are consuming essential items only). This leads to a slight decrease in peice level as shown in the diagram.

2. A cut in government spending leads to fall im aggregate demand, this leads to a leftward shift of AD to AD’. This shift leads to a situation of excess supply in the economy and puts downward pressure on price and output, thus, both price and output fall to P’ and Y’ respectively. As shown in the diagram

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